The above paper gave me an insight that it very necessary now for the insurers to constantly monitors its solvency issues in terms the major driving parameters

The above paper gave me an insight that it very necessary now for the insurers to constantly monitors its solvency issues in terms the major driving parameters. In my study I intend to do that for FILIC For this purpose I further dug into what the rating companies are doing to assess the life insurance companies and I have found that total qualitative evaluation of insurance companies which characterizes activities of insurance companies is a content of the rating evaluation carried out by credit rating agencies.
In Bangladesh there is a rating agency named ‘Credit Rating Agency of Bangladesh CRAB’ and it assesses the ability of the life insurers concerned to settle policyholders’ claims and obligation on time. The rating also analyses the product choice of insurance companies. The process involves analysis of business fundamentals, franchise value, organizational structure, competitive position, underwriting and investments strategies, liquidity, profitability, financial leverage, capital adequacy.

The most famous ones include A.M BEST, Standard ; Poor’s (commonly known as S&P Global), DUFF & PHELPS. I have studied the detailed analysis manual of A.M. BEST and my understanding is that A.M. Best uses five years’ data and the whole analysis is concentrated on major three pivots: Profitability, Leverage and Liquidity. Each pivot contains a series of tests as follows:

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Profitability
Yield on investments
Net Operating gain to Net Premium written
Net operating gain to total income
Return on equity
Benefits paid to net premiums written
Commissions and expenses to net premiums written
Return on Assets
Return on Equity

Leverage
Change in net premium written.
Direct premiums written to capital and surplus
Net premiums written to capital and surplus test
Surplus relief tests
Reinsurance ceded to gross premiums written.
Insurance exposure to capital and surplus.

Liquidity
Current liquidity
The overall liquidity

3.2 Research Methodology

Through this paper I have carried out:
A thorough ratio analysis in terms of profitability, leverage and liquidity.

Regression analysis involving life fund and the total revenue and total expenses including commission.

Correlation analysis premium income and commission expense.
3.3 Statistical Tools

For the above analysis I shall be using spreadsheet as my basic tool.
3.4 Data sources

I have communicated with the Mr. Hemayet Ullah CEO of the Company and with his permission I have collected data from the Finance and Accounts Department, Share Department and Actuarial Department.
I have used 18 years’ financial data of the Company as primary data sources. They are:
Annual Reports from year 2000 to 2016.
The Financial Indicators disclosed to Insurance Development & Regulatory Authority (IDRA).
3.5 Limitations

As there are no published guidelines regarding determination of solvency margin of life insurers in Bangladesh as yet, therefore I was unable to carry out the solvency margin test. In addition to that the available data was as per Bangladesh Accounting Standard which does not completely match with the format followed in US or Europe. For this reason I could not carry out some of the ratio tests.

Chapter Four: Results and Discussions
4.1 Ratio Analysis
A. Profitability Test
Profit is important to a strong and sustainable insurer. It measures the competence and ability of management to provide services and prices attractive to the policyholders in the competitive market. Some of the profitability tests are exercised below:
Yield on Investment
For life insurance companies the yield on investment “i” is calculated using the following formulae:

i= ((2*I)/(A+B-I))

Where: A = Life Fund as on beginning of the financial year.
B = Life Fund as on the end of the financial year.
I = Income on Life Fund (It is basically the item named ‘profit, dividend, rent’ item in the balance sheet)
Year A B I Yield
BDT (Cr.) BDT (Cr.) BDT (Cr.) %
2001 0.17 8.11 0.27 6.74
2002 8.11 19.55 0.99 7.40
2003 19.55 46.67 2.30 7.19
2004 46.67 87.89 5.35 8.28
2005 87.89 144.58 7.55 6.71
2006 144.58 237.47 15.08 8.22
2007 237.47 397.48 30.02 9.93
2008 397.48 589.93 43.04 9.12
2009 589.93 928.22 66.16 9.11
2010 928.22 1,352.95 113.13 10.44
2011 1,352.95 1,648.65 80.97 5.54
2012 1,648.65 2,080.42 172.20 9.68
2013 2,080.42 2,524.80 214.90 9.79
2014 2,524.80 2,886.28 188.40 7.21
2015 2,886.28 3,129.77 161.15 5.50
2016 3,129.77 3,216.61 150.29 4.85

Chart 4. 1: Year Wise Yield Rate
In the above trend the yield rate (Return on Life Fund) of the Company experienced a wide fluctuation and in the recent past years there has been a significant downward trend indicating that the Life Fund has not been invested in the most efficient manner and the Company definitely need to take immediate measures to improve the yield rate. The possible reasons for these fluctuations are:
Being an Islami Insurance company it invested in Islami Government Bonds where the rate of return is substantially low as compared to regular (non-Islamic) bonds.

Though the Company has decided to invest in regular government bonds, but currently the overall rate of return of the country is experiencing a downward trend.

Net Operating Gain to Net Premium Written
Consideration: I have considered actuarial surplus which is revealed in the actuarial valuation of policyholders’ liabilities as net operating gain.

Reason for consideration: This surplus is allocated to shareholders and policyholders as profit.

Twelve years’ data (2005 to 2016) for this calculation. The formulae used are:
Actuarial Surplus=Life Fund-Policyholders^’ Liability as per actuarial valuation.
Net Premium=Gross Premium-Reinsurance Premium
Ratio=((Actuarial Surplus)/(Net Premium))
Year Actuarial Surplus Net Premium Ratio
BDT (Cr) BDT (Cr) %
2005 29.59 111.05 26.64
2006 36.02 172.79 20.84
2007 71.52 238.70 29.96
2008 107.02 319.45 33.50
2009 156.28 630.79 24.77
2010 205.53 650.62 31.59
2011 167.80 689.98 24.32
2012 209.04 706.00 29.61
2013 272.02 708.46 38.40
2014 301.80 766.06 39.40
2015 269.36 849.64 31.70
2016 255.69 923.70 27.68

Chart 4. 2: Actuarial Surplus Vs Net Premium Ratio
There is an overall upward trend but there are also ups and downs indicating that the surplus has faced some stringent situation as compared to premium written. The major reasons
The Life Fund has not grown in the manner as it was expected i.e. the inconsistent and sometimes lower than average yield rate supports this reasoning.

The quality of policies underwritten is also a reason as good quality policies are less prone to claims. The Company should keep this thing in mind to control ‘adverse selection’

Net Operating Gain to Total Income
Consideration: Actuarial surplus have been used as the net operating gain and total premium income net of reinsurance plus investment return on life fund have been used as total income.

Twelve years’ data (2005 to 2016) for this calculation. The formulae used are:

Total Income=Gross Premium-Reinsurance Premium+Return on Life fund investment

Ratio=((Actuarial Surplus)/(Total Income))
Year Actuarial Surplus Total Income Ratio
BDT (Cr) BDT (Cr) %
2005 29.59 118.61 24.95
2006 36.02 187.87 19.17
2007 71.52 268.72 26.61
2008 107.02 362.50 29.52
2009 156.28 696.96 22.42
2010 205.53 763.75 26.91
2011 167.80 770.95 21.77
2012 209.04 878.20 23.80
2013 272.02 923.36 29.46
2014 301.80 954.46 31.62
2015 269.36 1010.80 26.65
2016 255.69 1073.99 23.81

Chart 4. 3: Actuarial Surplus Vs Total Income

The above graph shows that the actuarial surplus against total income ratio have been facing some fluctuations but as the investment return on life fund have been added now the ratio have decreased as compared to the last ratio. In the last two years there have a downward trend of the ratio indicating that actuarial surplus is facing a stringent situation. This can be mitigated by increasing the life fund growth.

Benefits paid Vs Net Premiums written
Consideration: Total benefits paid include all types of policyholder’s final settlement i.e. payment in respect death, maturity, surrender and survival (applicable for anticipated plans). The formula used is:

Ratio=((Benefits paid)/(Net Premium))

Year Net Premium Benefits Paid Ratio
BDT (Cr.) BDT (Cr.) %
2005 111.05 14.91 13.43
2006 172.79 22.77 13.18
2007 238.70 25.18 10.55
2008 319.45 42.52 13.31
2009 630.79 64.91 10.29
2010 650.62 66.23 10.18
2011 689.98 139.78 20.26
2012 706.00 173.23 24.54
2013 708.46 200.08 28.24
2014 766.06 263.97 34.46
2015 849.64 357.51 42.08
2016 923.70 542.62 58.74

Chart 4. 4: Benefits Paid Vs Net Premium

The nominal ups and downs till year 2010 reflect mainly the death benefit payments and the fluctuating surrender (encashment) of policies. From 2011 and onward there has been a significant rise in the ratio indicating high benefits payment as compared to net premium earned. Since inception the Company has sold bulk amount of saving policies i.e. plans with maturity values with terms 10 years and above. Those policies are gradually maturing from 2011 and onwards. Thus the high benefit payments are due to payments in connection to matured policies.

Commissions and Expenses to Net Premium
Consideration: Commissions refers to the business procurement cost and
Expenses refers to operating expenses.

Twelve years’ data (2005 to 2016) for this calculation. The formulae used are:
Ratio=((Commissions & Expenses)/(Net Premium))

Year Total mgt Expense +Commission Net Premium Ratio
BDT (Cr.) BDT (Cr.) %
2005 47.04 111.05 42.36
2006 72.31 172.79 41.85
2007 83.79 238.70 35.10
2008 127.77 319.45 40.00
2009 294.04 630.79 46.61
2010 273.39 650.62 42.02
2011 338.57 689.98 49.07
2012 274.56 706.00 38.89
2013 281.19 708.46 39.69
2014 329.15 766.06 42.97
2015 410.35 849.64 48.30
2016 449.47 923.70 48.66

Chart 4. 5: Commission & Expenses Vs Net Premium

The Company has incurred high expenses in terms of both commission and management (operating) expense and this has been one of the major drawback in the Company’s profitability. The main reason being that the packages paid to sales people are way above the industry norms. Though the company has taken many measure to control the expenses and it is even reflected in year 2012 but again there is rise since year 2013 and in 2016 the ratio was the second highest in the last 12 years.
Return on Assets
This ratio indicates how profitable a company is relative to its total assets. The Return On Assets (ROA) ratio indicates how well management is employing the company’s total asset to make a profit. The higher the return, the more efficient management is in utilizing its asset base. The formula used is:
Ratio=((Net Income before TAX)/(Total Assets))
Year Total Assets Total Income Ratio
BDT (Cr.) BDT (Cr.) %
2005 170.72 118.61 69.47
2006 272.88 187.87 68.85
2007 431.65 268.72 62.26
2008 645.13 362.50 56.19
2009 1,011.60 696.96 68.90
2010 1,461.18 763.75 52.27
2011 2,192.38 770.95 35.17
2012 2,822.23 878.20 31.12
2013 3,226.42 923.36 28.62
2014 3,865.62 954.46 24.69
2015 4,069.73 1,010.80 24.84
2016 4,114.06 1,073.99 26.11

Chart 4. 6: Return On Assets

Though in initial years the return on assets was high of around 69% but after 2010 it has fallen significantly and this downward trend is still continuing resulting in return of assets around 26% in 2016. The possible major reason can be during the last couple of years the Company has procured fixed assets (property) and those investments is not giving any return. The Company should be take this trend under serious consideration and immediate measures should be taken to improve the situation.
Return on Equity (ROE)
It is the ratio of net income of a business during a year to its stockholders’ equity during that year. It is a measure of profitability of stockholders investments. The formula used is:

Ratio=((Net Income)/(Total Shareholders^’ Equity))

Year Total Net Income Total Shareholders’ Equity Ratio
BDT (Cr.) BDT (Cr.) %
2005 118.61 152.17 77.94
2006 187.87 246.61 76.18
2007 268.72 407.59 65.93
2008 362.50 604.12 60.00
2009 696.96 948.05 73.51
2010 763.75 1,381.76 55.27
2011 770.95 2,022.30 38.12
2012 878.20 2,463.58 35.65
2013 923.36 2,915.66 31.67
2014 954.46 3,277.46 29.12
2015 1,010.80 3,526.86 28.66
2016 1,073.99 3,612.64 29.73

Chart 4. 7: Return Of Equity

Again the downward trend in the return of equity shows that there have not been growth in the shareholder’s equity as expected. Similarly to ROA this investment issues should be seriously reviewed and a dynamic strategy should be taken to improve it.

B. Liquidity Ratio Tests
An insurer should be prepared at all times to meet its obligations. Liquidity enables the insurer to meet unexpected need for cash without the untimely sale of investments. The major types of Liquidity tests are:

Current Ratio
This test measures the proportion of net liabilities covered by cash and unaffiliated investments. If this test result is less than 1, the company’s solvency could possibly be dependent on the collectability of premium balances or the marketability of investments in affiliates or other un-invested assets. The formula used:
Current Ratio= (Current Assets)/(Current Liabilities)
Current Assets=Total assets-Fixed Assets
Current Liabilites=Total liability –Provision
Year Current Asset Current Liabilities Current Ratio
BDT (Cr.) BDT (Cr.)
2005 159.12 18.55 8.58
2006 250.84 26.27 9.55
2007 393.59 24.06 16.36
2008 598.07 41.01 14.58
2009 977.76 63.55 15.39
2010 1,417.93 79.42 17.85
2011 1,754.24 122.54 14.32
2012 2,208.24 293.84 7.52
2013 2,606.88 248.10 10.51
2014 2,963.81 522.07 5.68
2015 2,868.04 467.95 6.13
2016 2,891.30 475.40 6.08

Chart 4. 8: Current Ratio
This ratio shows the availability of assets for use in the short term (that the assets which can be en-cashed within one year) to meet the liabilities which shall be met in the short term (within a year). As the graph shows the ratio was highest in 2010 but after that the ratio is decreasing indicating that the Company may face cashflow problem in the future. Therefore immediate measures should be taken to improve the current ratio.
Overall Liquidity Ratio
Overall liquidity ratio is the measurement of a company’s capacity to pay for its liabilities with its assets. The formulae used are:

Adjusted Liability=Total Liability–Provision against outstanding claim

Overall Liquidity Ratio= (Total Assets)/(Adjusted Liability)

Year Total Assets Adjusted Liabilities Overall Liquidity Ratio
BDT (Cr.) BDT (Cr.) %
2005 170.72 16.72 10.21
2006 272.88 20.55 13.28
2007 431.65 19.41 22.24
2008 645.13 37.10 17.39
2009 1,011.60 53.12 19.04
2010 1,461.18 71.67 20.39
2011 2,192.38 136.51 16.06
2012 2,822.23 334.80 8.43
2013 3,226.42 279.60 11.54
2014 3,865.62 563.41 6.86
2015 4,069.73 528.17 7.71
2016 4,114.06 438.93 9.37

Chart 4. 9: Overall Ratio

Again the ratio shows a significant fall after 2010 implying even if we consider the total asset against the liability (net of provision against outstanding claims) it will be tough to meet the liabilities with the existing asset level. The Company should immediately take this under consideration an apply measures to improve the situation.

C. Leverage Ratio Tests
The financial leverage ratio is a measure of how much assets a company holds relative to its equity. A high financial leverage ratio means that the company is using debt and other liabilities to finance its assets — and, everything else being equal, is more riskier than a company with lower leverage.
Debt to Equity Ratio
The debt-equity ratio is a leverage ratio that compares a company’s total liabilities to its total shareholder’s equity. This is a measurement of how much suppliers, lenders, creditors, and obligors have committed to the company versus what the shareholders have committed. The formulae used are:
Shareholder^’ s equity=Total assets–Total liabilities
Ratio= (Total Liabilities)/(Shareholder^’ s Equity)
Year Total Liabilities Shareholder’s equity Ratio
BDT (Cr.) BDT (Cr.)
2005 18.55 152.17 12.19
2006 26.27 246.61 10.65
2007 24.06 407.59 5.90
2008 41.01 604.12 6.79
2009 63.55 948.05 6.70
2010 79.42 1,381.76 5.75
2011 170.07 2,022.30 8.41
2012 358.64 2,463.58 14.56
2013 310.76 2,915.66 10.66
2014 588.16 3,277.46 17.95
2015 542.87 3,526.86 15.39
2016 501.42 3,612.64 13.88

Chart 4. 10: Debt Vs Equity Ratio
The debt to equity ratio is showing a upward trend since the past couple of years and this is not very favorable as this shows that the Company’s debt is increasing.

4.2 Regression Analysis

Commonly a life fund is thought of a portfolio which can be made up of stocks, bonds, cash and alternatives, into which policyholder’s life assurance premiums are paid into and claims are paid out of. In this research I intend to understand the relationship between Life fund, cash inflows life premium earned and investment return on life fund, cash outflows like claims paid and expenses incurred. I have decided to carry out a Multiple Linear Analysis taking the following assumptions under consideration.
Hypothesis
H0: The Life fund comprises of cash inflows and cash outflows.
H1: There is no such relation.
Variable
Independent variables
Total Revenue which comprises of gross premium income net of reinsurance premium plus the return on investment of life fund.

Total claims paid which comprises of claims in respect of death claim, maturity claim and policy encashment claims.

Total management (operating) expenses and commission (business procurement) paid to agents.

Dependent variable – The life fund is considered as the dependent variable.
The equation used for the regression analysis
Life Fund=Total Revenue-Total Claim-Total Expense ; Commission
Y =b_0+(b_1*X_1 )+(b_2*X_2 )+?(b?_3*X_3)+?_i
Where Y = is the dependent variable i.e. the life fund.
X1 = is the first independent variable i.e. the total revenue.
X2 = is the second independent variable i.e. the total claims paid.
X3 = is the third independent variable i.e. the total expenses (operational and business procurement) incurred.
Data Source
I have taken the data 12 years’ data from the Annual Reports of the Company.
Year Total Revenue Total Claims paid Total mgt Expense +Comm. Total Expense and Claims Life Fund
BDT (Cr.) BDT (Cr.) BDT (Cr.) BDT (Cr.) BDT (Cr.)
2005 206.54 14.91 47.04 61.96 144.58
2006 332.55 22.77 72.31 95.08 237.47
2007 506.46 25.18 83.79 108.98 397.48
2008 760.23 42.52 127.77 170.30 589.93
2009 1,287.18 64.91 294.04 358.96 928.22
2010 1,692.56 66.23 273.39 339.61 1,352.95
2011 2,127.00 139.78 338.57 478.35 1,648.65
2012 2,528.21 173.23 274.56 447.79 2,080.42
2013 3,006.07 200.08 281.19 481.27 2,524.80
2014 3,479.41 263.97 329.15 593.13 2,886.28
2015 3,897.63 357.51 410.35 767.85 3,129.77
2016 4,208.70 542.62 449.47 992.09 3,216.61

The result and interpretation
Regression Statistics
Multiple R 1
R Square 1
Adjusted R Square 1
Standard Error 0.000000
Observations 12

Coefficients Standard Error P-value Lower 95% Upper 95% Lower 99.0% Upper 99.0%
Intercept 0.00000 0.00000 0.000057 0.0000 0.0000 0.0000 0.0000
Total Revenue 1 0.00000 0.000000 1 1 1 1
Total Claims paid -1 0.00000 0.000000 -1 -1 -1 -1
Total mgt Expense +Commission -1 0.00000 0.000000 -1 -1 -1 -1

Correlation Coefficient (Multiple R) – the correlation coefficient is 1 implying that there is a perfect linear correlation among the independent and the dependent variables.

Coefficient of Determination (R square) – the value of 1 implies that the differences in the independent variables (revenue and expenses) fully explains the differences in life fund.

Adjusted R Square – implies that there are more than one independent variables. The value of implies that all the independent variables are perfectly related to each other.

Standard Error – is the precision of the regression coefficient measured. In the result the value of zero implies that is almost no error involved and the level of precision for the regression coefficient is close to accurate.

Observation – The value of 12 simply shows that 12 years’ data have been used.

Coefficient of regression equation: the coefficient of intercept is zero implying that if there is no revenue and expenses then there will be no life fund as well. The coefficient of total revenue is 1 implying that total revenue is in perfectly positive correlation with the life fund and the negative 1 value for the coefficient of both total claims and total expense incurred implies that they are in perfect negative correlation with the life fund.

P-value – the negligible p – value shows that there is enough evidence to prove that life fund is strongly dependent on the total revenue, total claims paid and the total expenses incurred. Thus there is not enough evidence to reject the null hypothesis.

Chart 4. 11:Comparison of cash-flows with life fund

The above line graph also supports the regression analysis that the life fund is the balancing figure of the total revenue and total expenses.
4.3 Correlation Analysis
While analyzing the premium income and expenses control in more detail I have observed that the new business costing is very high as compared to the old (renewal) business. Therefore in order to understand the exact impact of new business on the procurement cost and eventually on the expenses of the Company I have carried out a correlation analysis between the premium earned and the expenses incurred in order to procure (earn) that premium.
Data Source
I have taken the data 12 years’ data from the Annual Reports of the Company.
Year New Business Renewal Business Total Business Total Commission paid Ratio
Of Premium income to commission paid
BDT (Cr.) BDT (Cr.) BDT (Cr.) BDT (Cr.) New Business Renewal Total
2005 50.95 60.30 111.24 31.23 61.30 51.79 28.07
2006 78.80 94.09 172.89 52.07 66.07 55.34 30.12
2007 95.16 143.61 238.77 59.66 62.70 41.54 24.99
2008 120.99 198.76 319.76 82.73 68.38 41.62 25.87
2009 340.97 290.14 631.11 221.37 64.92 76.30 35.08
2010 277.19 374.11 651.30 172.22 62.13 46.04 26.44
2011 237.92 452.83 690.74 176.07 74.01 38.88 25.49
2012 157.64 546.70 704.34 116.12 73.66 21.24 16.49
2013 141.62 567.48 709.11 113.09 79.85 19.93 15.95
2014 189.02 576.67 765.69 133.73 70.75 23.19 17.47
2015 256.02 593.12 849.14 166.38 64.99 28.05 19.59
2016 322.12 600.34 922.45 206.79 64.20 34.44 22.42

Hypothesis test 1: correlation between new business and commission paid
H0: there is a positive correlation between the new (first year) business and the commission paid to agent i.e. procurement expense.
H1: There is no such relation.
Variable
The new business procured or the first year gross premium written.

The commission and other allowance paid to the sales people i.e. to insurance agents
Result and Interpretation
New Business Total Commission paid
New Business 1
Total Commission paid 0.98813 1

Pearson’s Correlation Coefficient (r) -From the above result, r = .98813 which can be considered as large effect we can see that higher first year premium is results in higher commission paid. That is there is not enough evidence to reject the null hypothesis and a strong positive correlation between these two variables prevails.

Hypothesis test 2: Correlation between renewal business and commission paid
H0: there is a positive correlation between the old (renewal) business and the commission paid to agent i.e. procurement expense.
H1: There is no such relation.
Variable
The renewal business procured or the first year gross premium written.

The commission and other allowance paid to the sales people i.e. to insurance agents
Result and Interpretation
Renewal Business Total Commission paid
Renewal Business 1
Total Commission paid 0.65213 1

Pearson’s Correlation Coefficient (r) -From the above result, r = .65213 which can be considered as moderately large effect we can see that higher renewal premium is results in higher commission paid. That is there is not enough evidence to reject the null hypothesis and a strong positive correlation between these two variables prevails. If we compare this with the first year business we can see that first year business has greater strain on expenses.

Chart 4. 12: Ratio of Commission Paid

The above figure shows that ratio of commission paid to new premiums paid is consistently quite high and on the other hand the ratio in respective of renewal business fluctuated during the last 12 years ranging from 76.3% in 2009 to 19.93% in 2013. This offsets the overall strain on the total business which is in more acceptable. Though new business is important but as the lion share of the premium earned is paid out as commission so in order to improve its sustainability the Company should aim on increasing the renewal business.

Chapter Five: Conclusion

After carrying out the series of analysis I have come to a conclusion that though FILIC has managed to earn the confidence of its policyholders but it should seriously emphasize on the investment strategies, managing its expenses, reducing the leverage.
The parameters affecting the life fund or the overall stability of the Company should be taken under scrutiny and a detailed recovery plan should be put into the table for the board of directors’ decision making.
As per my understanding the major parameters are the expenses (both operational and procurement), the profit earning or we can say the investment return, the level of renewal business and also the quality of policyholders to maintain the under writing profit.